November 14, 2011

Dodd-Frank Unlikely to Reach Foreign Shores

The Dodd-Frank Act does not apply extraterritorially, to activities outside the United States, unless those activities meet a threshold level of significance to the U.S. Under Section 722(d), for example, swaps regulation does not apply outside the U.S. except to activities that "have a direct and significant connection with activities in, or effect on, commerce of the United States."

Depending on how broadly regulators or courts interpret "direct and significant," a wide range of overseas transactions could be subject to Dodd-Frank. That could include, for example, requiring a European swaps dealer to abide by Dodd-Frank reporting, capital, margin, and business conduct standards if it enters into a swap with a U.S. institution. The problems with such an approach include subjecting non-U.S. institutions to duplicative or inconsistent regulation, and that doing so may make non-U.S. dealers reluctant to transact with U.S.-regulated institutions in the first place.

U.S. lawmakers recently took a significant step away from such a broad approach, however, by seeking to clarify and limit the extraterritoriality of Dodd-Frank swaps provisions in a bill, the Swap Jurisdiction Certainty Act.

With respect to extraterritoriality, the proposed bill would permit non-U.S. swaps dealers registered with the Commodities Futures Trading Commission (CFTC) to only comply with Dodd-Frank requirements with respect to their swaps with U.S. institutions, hence exempting themfrom complying with U.S. rules for their swaps with non-U.S. institutions. And even with respect to their swaps entered into with U.S. institutions, the bill would exempt registered non-U.S. swaps dealers from Dodd-Frank's capital requirements so long as their home country's regulations are comparable and the country is a Basel signatory.

Although the bill is in its early stages, it seems to reflect a growing acceptance of limiting Dodd-Frank's extraterritoriality as seen, for example, in recent remarks by CFTC Chairman Gary Gensler and in a number of commentletters on behalf of financial institutions to regulators. Importantly, the "mutual recognition" approach adopted by the bill (which allows complying with comparable non-U.S. regulation to substitute for complying with Dodd-Frank) will likely promote healthy regulatory competition.